Stocks Continue Churning, Nasdaq
Underperforms

THE WEEK JUST PAST FEATURED 300 companies reporting results, two congressional visits by Alan Greenspan and several noteworthy economic releases. But judging by the main stock indexes, the market was bored near to inaction by the blur of headlines.

The market sits right in the middle of a compressed trading range that has contained stocks for more than six weeks. Having rushed to anticipate stronger economic and corporate performance with its energetic surge in the spring, the market has settled into a churning pattern.

A late-afternoon levitation act by the indexes on Friday left the Dow Jones Industrials a scant 68 points higher on the week, at 9188. The Standard & Poor's 500 slipped four points to 993, near the mid-point of the range that's bound it since June 4, spanning from 962 to 1015. The week's high point for the benchmark came midday Monday, when the S&P bumped against the 1015 level for the third time in a month, failing again to overcome it.

For the first time in weeks, the Nasdaq sharply underperformed the overall market, dropping 25 points, or 1.5%, to 1708. Big Board-listed
IBM
and
Nokia
disappointed Wall Street with their earnings results and outlooks, which emboldened sellers. And faintly encouraging words from
Intel
and
Microsoft
weren't enough to stem the negative tide.

The inability of stocks to catch any wind in their sails from broadly positive profit trends is, at minimum, a sign of buyer's fatigue. According to Thomson First Call, second-quarter earnings- growth expectations rose to 7% from 5% a week ago, and forecasts for the third quarter have nudged above 13% from 12.6%.

It remains early in the reporting season. And last week's heavy helping of bank and brokerage-stock earnings, which benefited from frenzied mortgage demand and the firmer capital markets, provided a disproportionate boost to consensus forecasts.

Even the auto sector is reaping rewards from the housing boom --
General Motors
derived more than 80% of its quarterly earnings from its finance arm, which made half its money from home loans. GM will finance your car at 0%, but if you want a house and garage with it, the interest rates turn positive.

Those caveats duly noted, the firming of third-quarter numbers is a welcome departure from the previous two years, when second-half profit forecasts began tumbling in the summer months.

The question is whether investors will continue to use the solid fundamental news as an occasion to sell some winners. Next week's slate of earnings, which will include reports from 166 members of the S&P 500 and nearly a third of the largest 1,500 stocks in the market, will clearly test the strength of investors' hands.

With corporate news in focus, inter-market action might have occupied only the traders' peripheral vision. But that doesn't diminish its potential importance. Treasury bonds sold off sharply on perceptions that Greenspan's Federal Reserve would not be buying bonds outright as some had bet, boosting the 10-year Treasury yield above 4% for part of the week.

Decent economic data -- such as slightly higher industrial production, lower unemployment claims and a stronger Philadelphia Fed manufacturing index -- also chewed away at bond traders' nerve. It's worth noting that since the 10-year yield bottomed at 3.08% on June 13, the stock market has gone almost nowhere.

The last time the S&P 500 drifted in such a tight range for as long as this current stretch was during February and early March. The tense pre-war calm back then was broken by a wholesale selloff toward the old October lows, followed by the V-shaped reversal that evolved into the rally that has now leveled off. There's no telling whether the tedium will rupture again soon, though last July saw placidity quickly turn into a nasty selloff.

One emerging pattern in the market's favor is that it's not moving in unison across all sectors, the way it was early this year. In fact, tentative signs of money rotating from sector to sector arose last week.

That's not the sort of move that puts much of a dent in the tech sector's huge performance lead, but it bears watching.

NO, DESPITE WHAT MANY FRUSTRATED BEARS will tell you, it's not like 1999 all over again. Even though the Nasdaq is beating the Dow this year by a factor of 4 to 1, and even though speculative stocks have been outrunning low-risk ones, today's environment doesn't qualify as a bubble redux.

Back then, the leaders were triple-digit stocks soaring toward infinity on outlandish perpetual-growth forecasts. Today, single-digit stocks emerging from the shadows of bankruptcy are in front.

These stumpy stocks have traded like call options, as the corporate-bond market has strengthened and assured that many strapped companies might live, if not prosper. That could well be a problem some day for an economy with too much capacity, but for the moment the thrill of the reprieve trumps the likelihood of recidivism.

In '99, the Nasdaq made new all-time highs on almost every week. After the latest surge, the Nasdaq has recouped just 15% of what the index lost from the 2000 market top to the October low. Back then, overconfidence and greed gripped investors, while today hard-won skepticism is still evident in the short selling and options statistics.

This isn't to say the fundamental underpinnings of Nasdaq's tech tenants are all that strong. Or that a dangerous level of euphoria couldn't soon develop.

Though semiconductor production has sped up, possibly helping Nasdaq 100 earnings to reach the prevailing forecasts of 46% growth in 2003, those 100 stocks still trade at 37 times those optimistically projected operating profits. Low-priced maybe, but certainly not cheap.

But while valuation always matters eventually, it doesn't hold investors' attention at all times. And the history of past asset bubbles shows that "it's not completely unusual for equities to rebound sharply" after a bubble deflation, says Bear Stearns strategist Francois Trahan.

Mapping the course of burst bubbles past (see the nearby chart), Trahan shows that the Nasdaq is tracking the typical trajectory remarkably well. If it continues to levitate along that path it could tickle the 2000 mark late this year -- and then be lower two years later.

For the market as a whole, Trahan suggests that it's less like 1999 and more like 1975. After the '73-'74 bear market bottomed in early October 1974, the S&P sprang higher in the ensuing months, and in calendar-year 1975 the index gained 28%. That represented an overshot, to say the least. The index then traded roughly sideways for more than six years.

CITIGROUP OBLIGED A MARKET HUNGRY for yield last week, announcing a 75% dividend boost. That lifted the yield on its shares above 3%, and some analysts believe the dividend could rise further if Citi decides to match the earnings-payout ratios of other big banks.

The sweetened income stream is now one of the few things investors can know, touch and feel after a busy week for the company, in which Sandy Weill abdicated the CEO throne for a nonexecutive chairmanship until 2006. Insiders Chuck Prince, as CEO, and Robert Willumstad, as operating chief, were anointed, though they remain lesser-known quantities on Wall Street. Citi's earnings also arrived above expectations, and the company won the auction for Sears' credit-card business, as Weill's press clippings pile up during his final flourish.

LIBERTY MEDIA SHARES CHRONICALLY trade below the value of the company's assets, many of which are stakes in other public companies. Liberty also has unique cable programming businesses and interests in international broadband and satellite operations.

There's a neither-fish-nor-fowl problem presented by Liberty Media that weighs on its valuation. Investors who like the portfolio of public media holdings -- including
News Corp.,AOL Time Warner,Sprint PCS
and
XM Satellite Radio
-- figure they can buy them a la carte, on their own. Those interested in the operating businesses get a collection of other securities they may not want. The public stakes alone are worth nearly $28 billion, just under Liberty's $30 billion equity-market value.

Liberty Chairman John Malone has stated his interest in simplifying the corporate structure and making it more of an operating concern and less a holding company.

Robert Routh, media analyst at Natexis Bleichroeder, has proposed a strategy by which Liberty could achieve exactly that through a series of transactions. And the analyst believes the company is thinking along the same lines.

Routh posits that Liberty could buy in the 25% of
UnitedGlobalCom
that it doesn't yet own. UnitedGlobalCom houses international broadband assets, which he believes have been assigned virtually no value by the market right now.

Once UGC is brought inside Liberty, Routh thinks Liberty would cleave itself in two, with one unit housing international operations and the other the domestic programming businesses. The latter include Discovery Communications, Starz/Encore, Court TV, Liberty Satellite and the soon-to-be-acquired QVC.

Then shareholders would be able to exchange Liberty shares for new stock in the international unit, if they wished. Malone used a similar technique to separate a unit from his old Tele-Communications cable company.

This would simplify the company, allow Liberty to shrink its equity base and offer investors targeted interests in the two discrete units. Theory and experience suggest that this would reduce the discount assigned to Liberty shares.

The complicating element in this hypothetical simplification plan is Liberty's continued interest in buying the Universal entertainment assets now being auctioned by
Vivendi Universal.
Vivendi turned away Liberty's request for exclusive negotiations, then rejected
MGM's
$11.5 billion offer. Vivendi is being aggressive in seeking a healthy price for the Universal studio, cable channels and theme parks. That could mean the "winner's curse" might be visited on the prevailing bidder.

Routh believes the Universal movie and theme-park businesses would inject an unwelcome capital-intensive, hit-driven aspect to Liberty's business, though Universal's USA and Sci-Fi networks are an attractive fit.

Until the Vivendi auction is finished, the concern about what Liberty might pay will no doubt hamper the stock's progress. But if Malone resists buying Universal, then he can pursue his professed goal of rationalizing his company and lifting its quote from Friday's 11.25, and closer to Routh's fair-value calculation of 16.

Clayton shareholders were scheduled to vote Wednesday on whether to approve selling the company to Berkshire for $12.50 a share. As detailed here in recent weeks, several investment firms insist that's a lowball price, and on July 10 distressed-investment fund Cerberus approached Clayton about a possible alternative bid.

Late Wednesday, the shareholder meeting was adjourned for two weeks, so other possible acquirers have time to evaluate their options. Berkshire flatly stated it wouldn't raise its offer. Clayton shares have continued to trade above the deal price, and are hovering around 13. The speculators and arbitragers seem to be willing to accept 50 cents of maximum downside for the chance that either another buyer pays more or the Berkshire deal is called off and the stock rises on its own.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.